Lars Kjaergaard models inflation using a three-factor Gaussian method. This gives a simple description of derivatives linked to inflation and interest rates, and allows for fast evaluation. He then shows how the model can be calibrated

In the past few years, there has been growing interest in inflation-linked products. This has happened both on the investor side, where inflation is seen as an independent asset class, and on the liability side, where more work has gone into identifying and hedging inflation risks.

Lars Kjaergaard is chief analyst at Nordea Markets in Copenhagen. He would like to thank Jesper Andreasen for reading and commenting on the article, and for early suggestions on the work. The views expressed are those of the author rather than of his institution. Email: [email protected]

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